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CORPORATEGOVERNANCEINJAPAN
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Corporate Go v ernanc e
in J apan
Institutional Change and Organizational Diversity
Edited by
MASAHIKO AOKI
GREGORY JACKSON
HIDEAKI MIYAJIMA
1
3
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Contents
Preface vii
1. Introduction: The Diversity and Change of Corporate
Governance in Japan 1
Gregory Jackson and Hideaki Miyajima
PART I: CHANGES IN OWNERSHIP AND FINANCE
2. Relationship Banking in Post-Bubble Japan: Coexistence
of Soft- and Hard-Budget Constraints 51
Yasuhiro Arikawa and Hideaki Miyajima
3. The Unwinding of Cross-Shareholding in Japan: Causes, EVects,

and Implications 79
Hideaki Miyajima and Fumiaki Kuroki
4. Foreign Investors and Corporate Governance in Japan 125
Christina Ahmadjian
5. Venture Capital and its Governance: The Emergence
of Equity Financing Conduits in Japan 151
Nobuyuki Hata, Haruhiko Ando, and Yoshiaki Ishii
6. Corporate Governance in Financial Distress:
The New Role of Bankruptcy 179
Peng Xu
7. The Rise of Bank-Related Corporate Revival Funds 205
Noriyuki Yanagawa
PART II: CHANGES IN ORGANIZATION, EMPLOYMENT,
AND CORPORATE BOARDS
8. Business Portfolio Restructuring of Japanese Firms
in the 1990s: Entry and Exit Analysis 227
Tatsuya Kikutani, Hideshi Itoh, and Osamu Hayashida
9. Corporate Finance and Human Resource Management in Japan 257
Masahiro Abe and Takeo Hoshi
10. Employment Adjustment and Distributional ConXict
in Japanese Firms 282
Gregory Jackson
11. The Turnaround of 1997: Changes in Japanese Corporate
Law and Governance 310
Zenichi Shishido
12. The Performance EVects and Determinants of Corporate
Governance Reform 330
Hideaki Miyajima
13. Insider Management and Board Reform: For Whose BeneWt? 370
Ronald Dore

PART III: DIVERSITY AND INSTITUTIONAL CHANGE
14. Organizational Diversity and Institutional Chan ge:
Evidence from Financial and Labor Markets in Japan 399
Mari Sako
15. Conclusion: Whither Japan’s Corporate Governance? 427
Masahiko Aoki
Index 449
vi Contents
Preface
This volume grew out of a study group on corporate governance at the Research
Institute of Economy, Trade and Industry (RIETI) in 2002. The project was
motivated by a concern to take stock of the changes underway in corporate
governance in Japan. Our feeling was that the conventional understanding about
the Japanese Wrm was increasingly becoming outdated. At the same time, both
popular and academic commentators seemed all too often to either over claim
that little had changed in Japan, or to portray those changes in terms of
an inevitable process of convergence toward the model of ‘‘shareholder value’’
found in the United States. To bring this debate forward, we felt that a third
perspective was needed that was both empirically comprehensive and theore-
tically grounded. While some of this empirical work was becoming available in
Japanese language publications, our secondary goal was to bring together these
contributions and Wll out the picture of contemporary Japanese business in a
single English-language volume.
This type of long-term and inter-disciplinary project would not have been
possible without the unique support of RIETI. Founded in 2001 by the Ministry
of Economy, Trade and Industry (METI), RIETI has established a unique position
to facilitate lively exchange between independent social science research and
the formulation of public policy in Japan. RIETI was also able to host inter-
national scholars such as Mari Sako and Ronald Dore as visiting fellows to
support their contributions to this book. For this, we are very grateful

and hope this volume reXects the aim of bringing academic research to bear on
contemporary policy issues.
This publicat ion has taken a long time to realize, having outlived our study
group in Tokyo and turning into a collaborative eVort across diVerent continents.
Gregory Jackson took a new position at King’s College London in August 2004.
Hideaki Miyajima spent time as a fellow of the Reischauer Institute at Harvard
University from April 2004 to August 2005, and Masahiko Aoki returned to
Stanford after ending his tenure as President and Chief Research OYcer of
RIETI in March 2004. We must thank all those involved for their patience and
belief that the project would come to fruition.
We would like to thank the participants in the RIETI Policy Symposium
in October 2004 for useful comments and suggestions, especially Yuji Hosoya,
Hideshi Itoh, Juro Teranishi, and Masaru Yoshitomi. We are also grateful to a
number of people who kindly provided useful comments and suggestions on
various drafts of individual chapters: Kee Hong Bae, Simon Chadwick, Jenny
Corbett, Katsuyuki Kubo, Curtis Milhaupt, Mitsuharu Miyamato, Masao Naka-
mura, Hiroshi Osano, Han Shin, and Yishay Yafeh. Special thanks must be
extended to Hirohiko Nakahara from METI and Hiroyuki Yanai from the Japan
Association of Corporate Directors, both of whom were ongoing members of our
study group a nd brought important practical and intellectual insights to this
project. We thank Jennifer Wilkinson and Andrew Schuller at Oxford University
Press for their support and patience throughout the project.
Gregory Jackson would like to thank all the past and present staV at RIETI for
their support. Their patience and friendship during my stay at RIETI from 2002
to 2004 was beyond the call of duty and made it an unforgettable experience.
Special thanks go to Yukiko Yamazaki, for her excellent research assistance,
talented translation, and friendship throughout this project. My original interest
in Japan (and in corporate governance for that matter) was inspired by my
experience of working for Ronald Dore back in 1992, and it’s a particular honour
to complete this circle by including his contribution in this book. Turning this

interest into actual research in Japan would have not been possible without the
strong pers onal encouragement of Masahiko Aoki and Kozo Yamamura to whom
I owe my immense personal gratitude. Most of all, I would like to thank Nicola,
Henri, and Ella for their loving support. It’s been an adventure!
Hideaki Miyajima would like to thank Michael Cutler for his intensive help
for editing several chapters. Michael suggested various points to make the
chapters much more readable. Thanks go to Fumiaki Kuroki and Keisuke Nitta,
who were instrumental in helping to construct the micro databases of Japanese
Wrms used in parts of this book. Yurie Otsu provided excellent research support.
Finally, special thanks also go to Susan Pharr, Mary Brinton, and other members
of Reischauer Institute for Japanese Studies and US–Japan programs at Harvard
University. I beneWted a lot from their comments and, more gen erally, the
intellectual atmosphere at Harvard during the Wnal phase of writing and editing
this book.
Finally Masahiko Aoki would like to thank my co-editors, Gregory Jackson
and Hideaki Miyajima. Although the project was initially conceived and organ-
ized by myself at the inception of RIETI, the actual development and manage-
ment of the project in all aspects and throughout the period are mainly
due to them, as I was compelled to be occupied with many other duties as
President of RIETI between 2001 and 2004 and in other capacities thereafter.
However, my interests in corporate governance institution in general, and that in
Japan in particular, has remained acute and I am particularly happy that our
initial, intuitive beliefs in the ‘‘third perspective’’ has now been theoretically and
empirically shaped in tangible form as presented in this volume for academic and
public scrutiny. For this I am extremely thankful for all the contributors
of this volume. I would like to note my personal gratitude to two institutions:
the Economics Department of Stanford and the Graduate School of International
Corporate Strategy of Hitotsubashi University. The former was generous enough
to grant me a long leave of absence during my tenure at RIETI and the latter has
been providing an excellent visiting environment for continuing my research in

corporate governance after that.
Stanford, CA, London, and Tokyo
Masahiko Aoki, Gregory Jackson, and Hideaki Miyajima
viii Preface
1
Introduction: The Diversity and Change of
Corporate Governance in Japan1
Gregory Jackson and Hideaki Miyajima
This book addresses the evolving patterns of corporate governance among
Japanese corporations since the early-1990s. Since the collapse of the so-called
Bubble economy, the Japanese economy suVered from a long-term economic
slump. Alongside this, the Japanese Wrm entered a period of fundamental chal-
lenge to its post-war corporate governance institutions. Well-known features of
the Japanese Wrms, such as the main bank system, cross-shareholding, boards
dominated by insiders, and lifetime employment have undergone signiWcant
crises. Meanwhile, new patterns of corporate governance emerged through
legal reforms, as well as innovations in corporate Wnance and the organizational
architecture of business Wrms. Many changes suggest a step toward more market-
oriented corporate governance as found in countries like the United States or
Britain. However, less agreement exists over the underlying signiWcance of these
changes and the extent to which they imply a departure from the past Japanese
model of corporate governance. Understanding the current process of institu-
tional continuity and change is the central task of this book.
Empirically this book examines how various elements of corporate governance
have changed, and the inter-relationships between those changes. Corporate
governance is often deWned narrowly in terms of agency problems between
owners and managers. This book reXects a broader view of corporate governance
as involving relations among multiple stakeholders, such as individual share-
holders, institutional investors, banks, employees, unions and various groups
of managers. Corporate governance is also viewed as being embedded within

various institutional rules and beliefs that shape how these stakeholders interact
in corporate decision-making—including corporate law, the Wnancial system,
1 The authors thank Christine Ahmadjian, Masahiko Aoki, Gerald Curtis, Virginia Doellgast, Ron
Dore, Howard Gospel, Yuji Hosoya, Hideshi Itoh, Ricardo Peccei, Juro Teranishi, Steven Vogel, Darrell
Whitten, Peng Xu, and Masaru Yoshitomi for useful comments and suggestions. We also thank the
Research Institute of Economy, Trade and Industry (RIETI) for supporting this research. All errors are
our own.
labor law, industrial relations the prevailing career patterns and ideologies of
management, or the political economy regime, just to name a few.
Corporate governance also has qualities of a ‘‘system’’ or ‘‘regime’’ where
conWgurations of diVerent elements or institutions interact (Aoki 1994; Aguilera
and Jackson 2003).2 These interdependencies are particularly important for
understanding institutional change (Aoki 2001b). Complementarities between
institutions may present substantial barriers to cross-national diVusion of busi-
ness practices (Streeck 1996). But conversely, complementarities may entail that
change in one institution create momentum for changes in other inst itutions,
such that even if viability of a potential institution x is low, the presence of
complementary institutions or policy in other domains may amplify the impact
of change so that, once a momentum is initiated, x may gradually evolve as a
viable institution (Milgrom et al. 1991). Institutional innovation is often an
unintended consequence as institutions co-evolve and become rebundled into
new combinations or undergo ‘‘conversion’’ to new purposes (Streeck and Thelen
2005; Aoki 2007). The historical evolution of corporate governance in Japan
illustrates how institutions emerged in a piecemeal fashion, often Wtting together
in ways that were unintended rather than by design (Aoki 1997; Okazaki and
Okuno-Fujiwara 1999; Jackson 2001).
In the last several years, a handful of works in English have begun to explore
empirically various aspects of change in the Japanese Wrm (see, for example, Dore
2000; Hoshi and Kashyap 2001; Learmount 2002; Yamamura and Streeck 2003;
Jacoby 2004; Inagami and Whittaker 2005; Vogel 2006). This book aims to take

stock of these developments by bringing together scholars from diVerent discip-
lines including economics, management, sociology, and law. The contributions
reXect a common eVort to integrate empirical analysis drawn from new or unique
data sources, on one hand, with a comparative institutional analysis of the
Japanese Wrm, on the other (Aoki 2001b). In doing so, the book collectively
aims to address four inter-related questions:
. First, what sorts of changes can we observe empirically in the key features of
Japanese corporate governance?
. Second, do these amount to a fundamental change in Japan’s post-war
corporate governance institutions or an adjustment of the past system to
changed circumstances?
. Third, how are changes in the various aspects of corporate governance inter-
related?
. Last, what is the relationship between corporate governance arrangements
and Wrm performance?
2 This perspective draws insights from the growing literature on the comparative institutional
advantages of diverse varieties of capitalism (see Hall and Soskice 2001; Jackson and Deeg 2006), as
well as comparative institutional analysis in economics or historical institutionalism in political
economy (Thelen 1999; Aoki 2001b; Crouch 2005; Streeck and Thelen 2005).
2 Gregory Jackson and Hideaki Miyajima
In answering these questions, we argue that rather than a ‘‘lost decade,’’ Japan
has reached a major turning point in its post-war business history. As suggested
by the title of the book, we see this process of institutional change as being
tightly linked to a growing diversity of corporate governance practices across
Wrms. In developing this answer, section 1.1 begins by brieXy introducing the
main characteristics of corporate governance in Japan. Section 1.2 sketches
the economic and political forces promoting reform or change in corporate
governance. Section 1.3 introduces the main empirical Wndings of the subsequent
chapters in four areas: ownership and Wnance, Wnancial distress and corporate
restructuring, labor management, and the board of directors. Section 1.4 inter-

prets the emerging patterns of diversity and institutional change in light of
theories of the convergence or path dependence of national corporate governance
systems, as well as developing an empirically grounded typology of emerging
hybrid forms of corporate governance in Japan. The conclusion provides some
brief conjectures about future issues and developments.
1.1 CORPORATE GOVERNANCE AND THE JAPANESE FIRM
Various labels have been used to describe the system of corporate governance in
Japan, such as bank-based, relationship-oriented, network, insider, stakeholder,
or coordinated model of corporate governance. While seemingly deviating from
the shareholder-orientation and liberal market principles, a large body of research
documented the economic logic and competitive advantages of the Japanese Wrm.
The competitive strength of post-war Japan seemed not to rest on the allocative
eYciency of the market, but the organizational eYciency of Wrms generated by
the investment of stakeholders in developing and maintaining Wrm-speciWc
capabilities. Corporate governance has played an important role in facilitat-
ing these long-term investments and promoting cooperation, representing an
important alternative to the US model (Aoki 1988; Porter 1990).
Here we outline the main institutional features of corporate governance in
Japan in three broad areas: corporate ownership and Wnance, employment and
industrial relations, and the board of directors.3 As we shall see, these three
domains are also inXuenced by the role of the state. The salience of various
institutions has varied throughout the post-war period and any description is
inevitably stylized. The intention is to provide a picture of how the Japanese Wrm
looked up to the collapse of the Bubble economy in the early 1990s as a baseline
for understanding the subsequent trajectory of change.
Corporate ownership in Japan is characterized by ‘‘stable shareholders’’ with
reciprocally held cross-shareholdings among corporations and banks. The largest
3 Our description of the main institutional features of corporate governance in Japan is based
loosely around the model of the J-Wrm develop by Masahiko Aoki in various writings (Aoki 1984,
1988, 1994).

Change of Corporate Governance in Japan 3
single shareholder, which is often the main bank, does not typically exceed a 5%
stake but the web of small reciprocal cross-shareholdings often account for 20%
of shares and stable shareholders over 40%. These horizontal groupings form a
dense and stable network of long-term relationships (Kester 1992; Osano 1996).
These ownership ties often overlap with and underwrite various other coopera-
tive business relationships within corporate groups. These groups include both
the bank-centred horizontal keiretsu such as the Mitsubishi group (Gerlach 1992)
or the vertically structured keiretsu such as the famous buyer–supplier relation-
ships in the Japanese automobile industry (Sako 1992). Stable shareholders also
protect Wrms from hostile takeovers and short-term stock market pressures. In
return, stable shareholders received stable dividends and could expect mode st
growth of share prices. Meanwhile, more active institutional investors, such as
private pension funds, were generally absent until the early 1990s (see Jackson
and Vitols 2001).
The Japanese main bank plays a central role in monitoring management
(Aoki and Patrick 1994; Miyajima 1999; Miyajima and Aoki 2002).4 Bank
lending was the main source of external corporate Wnancing during Japan’s
period of high growth and was supported through the 1980s by regulatory
policies that restricted markets for bonds and equity, segmented Japanese Wnan-
cial institutions, and limited the options for household savings. The main ban k
traditionally has long-term relationships with client Wrms that involve providing
credit, maintaining equity stakes, oVering Wnancial services and advice, and,
importantly, helping to overcome information asymmetries with client Wrms.
The main bank monitors through a ‘‘contingent governance’’ mechanism (Aoki
and Patrick 1994). In good times or where the demand for external bank Wnance
remains low, management retains considerable autonomy. When performance
declines below a certain threshold, the main bank intervenes as a delegated
monitor on behalf of other banks and shareholders, often taking seats on cor-
porate boards and being active in corporate rescues. Banks undertake thes e costly

rescues, but recoup costs in the context of their long-term relationships. This
mechanism avoids expensive formal bankruptcy procedures and safeguards
against premature liquidations that disrupt long-term business relations with
suppliers or employees.
Japan is also well known as a stakeholder model of corporate governance, where
employee interests play a predominant role (Dore 2000). This idea of the Wrm as a
community of people is manifest in a number of human resource management
(HRM) practices geared to mobilize long-term commitment to the enterprise.
‘‘Lifetime employment’’ is a norm for regular and usually male employees in large
Wrms, which became institutionalized in tandem with the emergence of coopera-
tive enterprise-based unions in the early post-war period (Gordon 1998). While
lifetime employment reXects strong legal constraints on dismissals, Wrms also
4 The historical role of the main bank relationship has been recently debated (see exchanges in
Milhaupt 2002; Ramseyer and Miwa 2005). While these arguments cannot be addressed here, we
consider the conventional understanding of the main bank system as basically accurate.
4 Gregory Jackson and Hideaki Miyajima
invest in Wrm-speciWc skills and maintain internal Xexibility of employees with
regards to job functions within the Wrm or related Wrms. This system is supported
by seniority-related wages, a rank-hierarchy system of promotion, training
through job rotation, and a strong socialization into company culture (Koike
1988). Hence, mid-career hiring remains an exception and average job tenures in
Japan are high. In addition, employee participation facilitates informati on sharing
at the shop Xoor level (e.g. quality circles) and information and consultation at
the corporate headquarters (e.g. joint labour–management consultation over
major company decisions).
The board of directors is, in part, an extension of this internal promotion
system: the president is perhaps more a ‘‘top employee’’ than representative of
shareholders. These boards often grow to 20 or 30 members, consisting almost
entirely of internally promoted managers who have risen through the ranks of the
company as employees (Miyajima and Aoki 2002). Pay diVerentials between

board members and ordinary employees are extremely low and stock options
or incentive pay were almost non-existent until the late 1990s. Meanwhile,
external recruitment of top managers and independent outside board members
are uncommon. Any outsiders tend to come from banks, group companies,
or government ministries (Kaplan and Minton 1994). Given this structure,
Japanese boards reXect a low degree of formal separation between strategy and
operations, as well as monitoring and management roles. Monitoring is a legal
duty of the statutory auditor (kansayaku), who has the right to attend board
meetings but no power to appoint or dismiss the CEO. Hence, the statutory
auditor has evolved as a largely honorary position bestowed to former employees
in their transition to retirement. Meanwhile, other mechanisms of internal
governance may be important to explain managerial accountability in Japan
(see Blair 2003; Hirota and Kawamura 2003) rooted more in bottom up consen-
sus building, and the strong social norms and loyalty among life-long co-workers
(Dore 2005).
Japanese corporate governance has co-evolved alongside its political institu-
tions. Post-war economic policies were developed through strong but informal
linkages between the Liberal Democratic Party, government ministries and
industry (Aoki 2001b). The Ministry of Finance (MOF) and Ministry of Inter-
national Trade and Industry (MITI) helped share the beneWts of growth across
diVerent Wrms and sectors through subsidies, protections and credit allocation.
While large Wrms beneWted from support, these Wrms also internalized many
social welfare functions. This pattern of ‘‘administrative guidance’’ promoted a
cohesive and solidaristic mode l of national political economy. Although not
without its critics or skeptics, the post-war Japan state achieved both high
economic growth and social equality by actively organizing and placing con-
straints on the role of markets (Yamamura and Streeck 2003).
In sum, Japanese corporate governance involves a number of inter-related
elements that are argued to display institutional complementarity (Aoki 1994).
Complementarity may be deWned as situations where the diVerence in utility

diVerence between two alternative inst itutions U(x’)ÀU(x’’) increases when an
Change of Corporate Governance in Japan 5
institution z’ rather than z’’ prevails in domain Z, and vice-versa, such that x’
and z’ (as well as, x’’ and z’’) complement each other and constitute alternative
equilibrium combinations (Milgrom and Roberts 1990; Milgrom et al. 1991;
Aoki 2007). For example, insider-oriented boards serve to protect the Wrm-
speciWc investments necessary to support commitment work practices, but are
also complemented by contingent governance by the main bank. Many other
examples can be cited. The complementary nature of these institutions also
supported a set of distinct comparative institutional advantages of Japanese
Wrms (Hall and Soskice 2001). After initially catching-up to the technological
frontier of the US, distinct advantages emerged for incremental innovation
in product quality and process in manufacturing sectors. The long-term nature
of employment, high skills, and cooperation with suppliers allowed Japanese
Wrms to build strong organizational eYciencies, in the sense of Leibenstein
(1966).
Given the ‘‘coordinated’’ nature of Japanese business groups and strong com-
plementarities between their diVerent elements, Japanese Wrms also displayed a
high degree of institutional isomorphism. Institutional isomorphism refers to the
attempts to gain legitimacy, reduce uncertainty or adapt to social norms that lead
Wrms in a population to resemble other Wrms facing the same institutional
conditions (DiMaggio and Powell 1991; Aoki 1998). Particularly from the
1960s to the 1990s, Japanese Wrms reXected a rather homogeneous ‘‘national
model’’ with relative low variation across Wrms relative to more liberal market
economies like the US. Of course, some variation has always existed as to the
extent of keiretsu-aYliation, reliance on main bank lending, or employment
conditions between core or more peripheral Wrms. Some successful Japanese
Wrms have remained relatively independent of traditional corporate groups, due
to the legacies of charismatic owner/entrepreneurs (e.g. Sony) or family owner-
ship (e.g. Suntory). However, on the whole, post-war Japanese Wrms came to

follow a remarkably uniform pattern of organization.
1.2 THE FORCES AND POLITICS OF CHANGE
In hindsight, the early-1990s marked a peak in scholarship on the economic
virtues of the post-war Japanese Wrm, but also expressed an impending sense of
change (Aoki and Dore 1994). Growing international competition, it was sug-
gested, may drive a convergence of corporate governance across countries—either
by combining best practices across countries into a single model or through the
imposition of one dominant system. Even if national diVerences were to be
preserved, Masahiko Aoki argued that Japanese Wrms would adopt a ‘‘hybrid’’
model that involved at least partial adaptation to internat ional constraints, but in
ways conditioned by existing national constraints (Aoki 1988, 1994). Others
predicted change due to shifts in social values and broader social change that
may undermine social solidarity. As Ron Dore (1994: 390) noted, ‘‘Japan’s
6 Gregory Jackson and Hideaki Miyajima
competitors . . . can look forward to the erosion of togetherness, just as has
occurred in Britain, as Japanese society becomes progressively internationalized.’’
Over the 1990s, corporate governance in Japan underwent substantial change,
as well as reXecting a growing diversity and more varied fortunes (see Table 1.1).
Ownership by foreign and institutional investors increased, while stable and cross-
shareholding arrangements eroded. The importance of bank lending decreased in
large Wrms, while increasing in smaller ones. After 1997, Japanese Wrms began to
launch board reforms by introducing outsider directors, executive board systems
and stock options. Many mature Wrms began to slowly reduce levels of diversiWca-
tion and consolidate their businesses, change their internal structures from a
uniform functional structure to the decentralized in-house company system
Table 1.1 Changes in Corporate Governance Structure, 1990–2000
The end of FY 1990 The end of FY 1995 The end of FY 2000
Average
Standard
deviation Average

Standard
deviation Average
Standard
deviation
Ownership
structure
Institutional
investors:
9.28 6.87 11.79 8.52 12.89 11.76
Foreign: 4.38 6.79 7.80 8.51 8.13 10.13
Stable shareholders: 25.35 11.19 23.71 11.15 18.71 11.41
Cross-shareholding: 14.63 8.52 14.07 8.41 10.99 8.55
Individuals: 20.62 8.43 22.49 10.10 29.18 14.28
Largest ten
shareholders:
45.22 12.07 43.86 12.51 45.01 13.98
Debt Debt/Asset Ratio: 51.57 17.77 50.00 19.49 49.60 23.55
Borrowing from
main bank/total asset:
4.61 4.92 5.29 5.77 – –
Board
composition
Number of
directors:
18.72 7.84 17.73 7.66 12.88 6.18
Number of auditors: 2.94 0.53 3.86 0.53 3.81 0.55
Number of outside
director:
3.69 3.56 3.93 3.65 3.36 3.39
From Banks: 0.69 1.40 0.62 1.18 0.48 0.94

From parent Wrms: 1.09 2.46 1.12 2.51 1.00 2.25
Number of Wrms
introducing the
executive
oYcer system: 476 Wrms/1333 Wrms(the end of FY 2002)
Stock option: 333 Wrms/1333 Wrms(the end of 2002)
Organization
structure
DiversiWcation
index:
.58 .56 .56
Percentage of Wrms
adopting in-house
company system:
4.5 5.5 17.1
Percentage of Wrms
adopting pure holding
company: 0.0 0.0 1.6
Change of Corporate Governance in Japan 7
(similar to a US multi-divisional pattern) or holding company structure. In this
section, we review the forces behind these changes, and their emergence since the
mid-1990s, namely: internationalization, the deregulation of the banking sector
and banking crisis, changing technological paradigms, and the politics of corpor-
ate governance reform.
1.2.1 From Strengths to Weaknesses?
After riding high on the Bubble economy of the 1980s, Japanese corporations
faced a serious performance crisis and new governance dilemmas during the
1990s. As recession turned into deXation and the banking crisis emerged, this
crisis grew more severe through the mid- and late 1990s. Past economic strengths
seemed to erode, and potential weaknesses that had remained latent during the

period of high growth became more acute. Table 1.2 presents, in highly stylized
terms, a set of theoretical arguments about how various strengths also came to
imply potential weaknesses. The main bank system may play a signiWcant role
for reducing asymmetric information and mobilizing patient investment, but
may be less eVective under conditions of slowed growth and greater Wnancial
liberalization, thus leading to problems of adverse selection of clients and declin-
ing monitoring capabilities. Cross-shareholding may safeguard top management
focus on long-term busin esses strategy, but also act as a precondition for vest-
ing insider control and preventing strategic change of Japanese Wrms. Lifetime
Table 1.2 Hypothesized Strengths and Weaknesses of J-type Firms
Golden age
behaviour
Function during
Golden Age Characteristics
Function after
Bubble
Early 1990s
behaviour
Risk sharing Horizontal corpor-
ate groups
Moral hazard
Growth
oriented
Mitigating pressure
from myopic stock
market
Stable shareholder
schemes
Less discipline
on manage-

ment
Excess
investment
Long-term
investment
Continuity of
management
One-tier insider-
dominated board
Less response
to external
changes
Empire
building
Delay in
restructuring
Organizational
eYciency
Increasing
no. of positions
Long-term
employment
Keeping a
division or a
subsidiary
with low
performance
Delay in
entering
new business

areas
Preventing from
excess liquidation
Preserving
Wrm-speciWc skills
Mitigating asymmetric
information
Main bank system Soft-budgeting Delay in
restructuring
8 Gregory Jackson and Hideaki Miyajima
employment and seniority wages contribute to investment in Wrm-speciWc skills,
but potentially hinder or delay needed restructuring. The insider-dominated
board structure and managerial career patterns assure the continuity of business
policies and long-term view, but also favour business conservatism and empire
building. Some studies even suggested corporate governance arrangements are
one of the main reasons for the long run recession, and led to criticism of the past
understandings of the J-Wrm (Hall and Weinstein 1996).
During the 1990s, the performance of listed Wrms, as measured by return on assets
(ROA), declined and also became much more heterogeneous during the long reces-
sion especially in the period after 1998 (see Figure 1.1). The growing diversity in
performance is not due simply to performance diVerence among industries.
Rather, the variation in performance among Wrms in the same industry has also
increased as shown by the standard deviation of ROA. Various studies have also
suggested that certain governance patterns such as cross-shareholding or main bank
tiesmay beassociatedwithpoorWrmperformance(WeinsteinandYafeh1998;Morck
et al. 2000) and such poor performance may, in theory, be an important driver of
change. But through the late 1990s, poorly performing Wrms faced few mechanisms
of competitive selection—such as bankruptcy, an active market forcorporate control
or the like. It also appeared uncertain as to whether adopting certain corporate
governance reforms would actually improve performance. For example, piecemeal

imitation of US corporate governance practices may not produce the desired eVects
in Japan, due to the absence of other complementary supporting institutions.
During this weak economic climate of the late-1990s, corporate governance
reform emerged as a serious issue in Japan. Due to its upswing in performance, the
7 4
3.5
3
2.5
2
1.5
6.5
6
5.5
5
4.5
4
3.5
3
2.5
2
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Figure 1.1 Average, standard deviation of ROA
Notes:Non-Wnancial listed Wrms at Tokyo Stock Exchange Wrst Section; Standard deviation among Wrms;
ROA; Standard deviation of normalized ROA (ROAi - ROAi).
Change of Corporate Governance in Japan 9
US economy again became a benchmark for reform eVorts. European countries
also intensiWed Wnancial market integration, which involved reforms in capital
market regulation, disclosure, transparency, takeover regulation and (to a lesser
extent) board practices and compensation. Critics argued that Japan lagged
behind and this sentiment was fuelled further by various corporate scandals.

The practice of paying Japanese corporate racketeers (sokaiya) became increas-
ingly exposed in cases such as Nikko Securities and Daiwa Securities in 1997.
Other scandals related to internal control issues, such as copper trading losses at
Sumitomo Corporation in 1996, product defect cover-ups by Mitsubishi Motors
in the 1990s, scandals surrounding food safety in 2000 and mislabeling of meat in
2002 at Snow Brand, or the empire building and collapse of Sogo Department
store chain in 2000. Still, much ambivalence remains about whether US-style
corporate governance practices are suitable for Japan. The idea that corporations
should Wrst and foremost serve the interests of their shareholders remains at odds
with other elements of solidarity and equality within Japanese society. Shareholder
value may also undermine past strengths of Japanese Wrms, and critics of the US
model rightly cite the problems of excessive executive pay and short-termism.
The scandal at Enron also reawakened many of these criticisms, which tended to be
overlooked during the economic boom of the late 1990s. Before pursuing these
political debates further, we next introduce three sets of speciWc pressures on
Japanese corporate governance.
1.2.2 Internationalization
A Wrst set of pressures on corporate governance stems from the changing inter-
national environment of Japan. In March 2005, foreign investors owned 23.7% of
stocks listed on the Tokyo Stock exchange in terms of market value, compared to
just 14.1% in 1999 and 6% in 1992 (TSE various years). Stock market turnover
increased dramatically from 27% of market capitalization in the low year of 1992
to a historically high level of 108.8% in 2005 (TSE various years). Foreign
investors accounted for just 9.8% of stock market transactions in 1990, but
34.3% in 2005. The perceptions of foreign investors thus play a key role in market
movements, and hence the Wnancial stability of stable shareholding patterns
among Wrms and banks. The shift toward corporate bonds over bank loans
among large Japanese Wrms also gives greater inXuence to international credit
agencies.
Since the late 1990s, foreign direct investment emerged as a key policy priority

in Japan aimed at revitalizing the economy. Here corporate governance reform
was intended to promote international investment by facilitating M&A, privat-
izing government business, or liberalizing the use of stock options that foreign
Wrms used as incentives to attract qualiWed staV. FDI into Japan did increase, and
foreign companies made unprecedented acquisitions of large stakes in major
companies. The results have been mixed as seen by the two contrasting examples
of Renault Motors purchase of a stake in Nissan in 1999 or DaimlerChrysler stake
10 Gregory Jackson and Hideaki Miyajima
purchase in Mitsubishi Motors during 2000. The Nissan case gained publicity as a
successful rejuvenation of the Wrm under new leadership. Meanwhile, Mitsubishi
Motors proved riddled with scandals, and Daimler eventually divested its stake in
2005. A further spectacular example concerns Ripplewood Holdings involvement
in the formation of Shinsei Bank and subsequent IPO, which generated large
proWts for the US investor group. Alongside inward FDI, Japanese companies
have become increasingly internationalized with overseas production facilities
and operations. Multinational Wrms often want to increase internal transparency
and use global standards familiar to stakeholders abroad. For example, Toyota
cites its main motivation for introducing the executive oYcer system in 2003 as
being to realize the global group management, although board members remain
company insiders and are still required to have shop-Xoor experience.
These trends have increased the salience of international standards for Japanese
Wrms. For example, the principles of corporate governance spelled out by the
OECD in 1998 generated substantial debate in Japan. The Japan Corporate Gov-
ernance Forum (JCGF), a private study group of academics and business leaders,
issued a set of voluntary corporate governance principles that focused on intro-
ducing independent outside directors, as well as improved transparency and
disclosure (JCGF 1998). The JCGF more recently developed its own index of
corporate governance practices in order to rank the compliance of listed com-
panies with its guidelines (JCGF 2005). Subsequently, the Tokyo Stock Exchange
adopted corporate governance principles along the lines of the OECD guidelines

in 2004. The content is notably broad and reXects a compromise of diverging
viewpoints, such as by stressing shareholder interests but within a context of
obligations to a wider set of stakeholders. Importantly, however, the TSE prin-
ciples do not have the force of mandatory listing requirements or British ‘‘comply
or explain’’ rules (TSE 2004 ). 5
International accounting rules have also become more salient. Japanese
accounting traditionally allowed asset valuation at cost rather than market
value. Meanwhile, both US GAAP (Generally Accepted Accounting Practices)
and IAS (International Accounting Standards) are signiWcantly more share-
holder-oriented by stressing market valuations and strict deWnitions of proWts.
Japan initiated accounting reforms in 1996 through the Ministry of Finance as
part of the Wnancial Big Bang called for by Prime Minister Ryotaro Hashimoto in
1996. The banking crisis helped mobilize political support for reform and opened
a window to push changes in line with US pressure. Despite high adjustment costs,
parliamentary opposition proved politically costly and led the inXuential business
association, Keidanren, to eventually express support for the recognition of
US Securities and Exchange Commission (SEC) standards under domestic law
(Keidanren 2001).
5 The TSE committee rejected these on the grounds that Wrms needed suYcient time to adjust
recent legal changes and experiment with various new corporate governance practices, rather than
being pushed toward a single model at the early stage of reform (TSE 2004).
Change of Corporate Governance in Japan 11
Finally, international standards sometimes may also have direct extra-territorial
application to Japanese companies, such as listing requirements on foreign stock
exchanges (CoVee 1999; Gilson 2000). Japanese companies listing on the New
York Stock Exchange (NYSE) is not a new phenomenon. Only ten of the 19
Japanese Wrms now listed on the NYSE obtained their listings since 1990, and
companies such as Sony, Matsushita, or Honda have been listed since the 1970s.
The impact of the Sarbanes-Oxley (SOX) again raised concerns about compati-
bility between US and Japanese practices, but the fallout appears to be relatively

mild. The statutory audit or system was recognized as being acceptable under SOX,
whereas Japan’s new committee system ironically has greater diYculty since these
Wrms must give much additional explanation of how their boards operate. SOX is
unlikely to lead to radical reforms of Japanese practices. If anything, SOX seems to
have led Japanese Wrms to withdraw from the US market.6 For example, Daiwa
Securities have delayed their listing on the NYSE and Ito-Yokado delisted from
Nasdaq in May 2003 after 25 years.7
1.2.3 Financial Deregulation and the Banking Crisis
Despite their importance, international pressures alone are not suYcient to
explain changes in Japanese corporate governance. One reason is that the pro-
portion of Wrms exposed to foreign investors, listing requirements and inter-
national bond ratings remains fairly small. A second set of forces for change relate
to domestic Wnancial deregulation. Financial deregulation in Japan was a gradual
process spanning the mid-1970s to mid-1990s, culminating in the so-called
deregulatory Big Bang (Hoshi and Kashyap 2001; Toya 2006). Following the oil
crisis and expanding public debt of the 1970s, Japan deregulated the secondary
market for government bonds in 1977. From that time onward, the strict criteria
for issuing corporate bonds were gradually lowered. The corporate bond
market also beneWted from the parallel development of new Wnancial products,
abolishment of controls on foreign exchange and removal of interest rate con-
trols. Further deregulation allowed Wrms to issue equity at market prices. These
factors led to a great increase in equit y Wnance, particularly during the bubble
years of 1987–90.
Growing choices in corporate Wnance also led to a very gradual erosion of
bank–Wrm relationships. Whereas in 1970s ban k debt represented some 36% of
assets among listed manufacturing Wrms, this Wgure dropped to 12.7% in 1990
and has remained low (Hoshi and Kashyap 2001: 247). Slowing macroeconomic
growth led corporations to cut investment and curtailed demand for external
funds. By the mid-1990s, the Japanese corporate sector had a net surplus of funds
and aggregate bank lending to large manufacturing Wrms slowed (EPA 1999).

6 No Japanese Wrms have listed or de-listed from the NYSE following three Japanese Wrms listing in
2002, three listing in 2001, one listing and one delisting in 2000.
7 We are indebted to Darrell Whitten for these observations.
12 Gregory Jackson and Hideaki Miyajima
Meanwhile, large corporations could increasingly raise external funds by directly
issuing corporate bonds, and often used these funds to write oV or reWnance bank
loans. Bonds became increasingly attractive in Wnancing international expansion
by raising funds in local currencies. Japanese corporate bonds also beneWted from
very low interest rates in Japan. The growing independence of larger Wrms from
banks continues to be reXected in the more than doubl ing of outstanding
corporate bonds between 1996 and 2004 to around ¥6.3 trillion (TSE various
years).
Japan also experienced a Bubble Economy during the late 1980s, followed by a
rapid collapse of the stock market in the years 1990–92 and subsequent macro-
economic stagnation. By 1997, Japanese banks were left with a huge legacy of
non-performing loans (NPLs) and losses on stoc k purchased at the height of the
Bubble. During the Bubble, banks had compensated for the decline in borrowing
by large lending by lending to new clients such as small and medium size
enterprises—particularly, risky construction ventures during the land price
asset boom. While large Wrms reduced their dependence of bank loans, smaller
Wrms without good access to bond markets became even more dependent on
banks as the economic situation deteriorated (Arikawa and Miyajima 2005).
At their peak in March 2002, the resulting non-performing loans of major
banks (city banks, trust banks, and long-term credit banks) were recorded to be
¥28.4 trillion or 9.6% of all outstanding loans. Following mounting criticisms of
government inaction, the passage of the Financ ial Revitalization Program in
October 2002 represented an important turning point that has allowed banks to
address to the NPL issue, reducing the overall volume of bad loans to ¥7.6 trillion
or 3.2% of outstanding loans by major banks in the end of FY 2004.
As the banking crisis unfolded, the corporate governance role of Japanese

banks was greatly aVected. Banks reduced outstanding loans to meet capital
adequacy ratios despite the Bank of Japan’s zero interest rate policy. Meanwhile,
the introduction of market-based accounting further exposed balance sheet losses
from shares. Given the banks’ own Wnancial stress, loans to bankrupt clients were
rolled over and undermined the credible threat of bank intervention in client
Wrms. Thus, banks had not only lost large Wrms as clients, but were less eVective in
governing relationships with remaining Wrms. Financial distress also led banks to
sell and repurchase cross-shareholdings in order to book unrealized gains and
improve balance sheets. But eventually the shift sparked a large divestment of
banks from stable shareholdings. Whereas city banks and other banks accounted
for 15.6% of share ownership in 1992, this Wgure was just 11.3% in 2000 and 5.3%
in March 2005 (TSE various years). Meanwhile, banks have reorganized as new
banking groups, with shares now held within separate subsidiaries under new
holding company structures. The banking crisis sparked further pressure for
deregulation and shift toward a more transparent and rule-based regime of
Wnancial regulation. A key element was the creation of the Financial Services
Agency (FSA) independent from the MOF. Greater transparency and market-
oriented accounting rules further reduced advantages of private information that
underpinned relational contracting between Wrms and their main banks. The
Change of Corporate Governance in Japan 13
future of the main bank system and capacity of Japanese banks to act as eVective
corporate monitors represents a key issue to be explored in this book.
1.2.4 Shifts in Organizational Architecture
A Wnal set of pressures for change relate to the organizational architecture of
Wrms. The relative eYciency of diVerent forms of corporate governance depends,
in part, on market and technological conditions that shape patterns of innovation
in particular economic sectors. As stressed by the resource-based theories of
the Wrm (Barney 2001), the internal capacities for coordination and the process-
ing of information within the Wrm should match or Wt with environmental
conditions. Depending on the relative importance of idiosyncratic local infor-

mation or systemic environmental information, diVerent organizational archi-
tectures may be more eVective and require diVerent sets of corporate governance
arrangements (Aoki 2001b). For example, corporate governance may thus diVer
over the ‘‘life-cycle’’ of the Wrm through its birth, development, maturity, and
decline (Filatotchev and Wright 2005).
Traditionally, Japanese Wrms had strengths in incremental innovation, which
allowed gradual improvements in process and product quality, based on integrated
organizational architectures and strong shop Xoor skills. When compared to the
‘‘short-termism’’ of the liberal US model, Japan’s strength rested on it’s superior
ability to mobilize long-term investment through bank Wnance and long-term
employment (Porter 1990). However, after the end of Japan’s post-war period of
high growth, main bank relationships and long-term employment were argued to
be less well adapted to promoting corporate restructuring and consolidation of
mature or declining industries. In addition, the rapid advancement of information
technology (IT) and radical innovation in Welds such as biotech gave renewed
competitive advantages to the US. Its corporate governance institutions support
radical breakthrough technology through more rapid entry and exit from business
areas, as well as a large supply of risk capital for venture Wnance. Debates emerged
about how to promote new models of innovation (see Yamamura and Streeck
2003), particularly by supporting stock markets, venture capital Wnance, and
stronger external labor markets based on portable professional qualiWcations.
These changes led to a historically high level of ‘‘creative destruction’’ in Japan
since the late-1990s. First, a high number of new Wrms were created, which was
reXected by an average of 99 new Wrms being listed per year during the period
1997–2004, compared to just 36 per year during 1990–96 or only 26 per year
between 1981–89. Similarly, 41 Wrms delisted from the stock exchange per
year between 1997–2004 compared to just four or Wve Wrms per year during the
1980s and early 1990s. Second, Wrms have rapidly sought to restructure their
business portfolios, as reXected in the high level of both entry and exits from lines
of business. Third, mature Wrms in stagnant or declining industries have under-

gone major corporate restructuring and consolidation. Large and mature Wrms,
such as Hitachi or Matsushita, have increasingly decentralized their business
14 Gregory Jackson and Hideaki Miyajima
decisions by introducing so-called in-house company systems which made it
possible for each business unit (in-house company) to enjoy independence
in decision making with clear responsibility. It is also getting popular to intro-
duce new group management through holding companies. These changes are
closely linked to changes in corporate boards, such as the introduction of the
executive oYcer system and greater separation of monitoring and management
functions.
All of these changes draw increasingly on mergers and acquisitions (M&A).8
The number of M&A transactions increased from 252 per year in 1991–97 to 1381
deals annually in 1998–2005. Their value increased from 0.4% to 2.5% of GDP
during those same periods. While M&A in Japan remains behind other large
OECD countries, this increase represents a massive change for Japanese Wrms.
While many M&A transactions remain within traditional corporate groups,
poorly performing Wrms have been targeted in M&A transactions at higher
rates than US or UK Wrms. Still, only 15 cases emerged of meaningfully ‘‘con-
tested’’ control through hostile stakebuilding or unsolicited oVers during the
period 1991–2005. Of these, the only successful hostile takeover was of Inter-
national Digital Commun ication by Cable & Wireless PLC in 1999. Nonetheless
these cases have attracted strong media attention, such as Livedoor’s bid for
Nippon Broadcasting System (NBS).9 Thus, while hostile takeover attempts
remain relatively rare, a growing threat of hostile bids is perceived and has
prompted METI to issue guidelines with regard to defensive measures, such as
poison pills.
1.2.5 Path Dependence and Politics of Corporate Governance Reform
While Japanese Wrms face many pressures to reform their corporate governance
practices, these pressures aVect diVerent groups of Wrms to greater or lesser
degrees. They also do not necessarily engende r a unanimous or coordinated

response. Policy makers and practitioners have lacked a clear consensus about
the strengths and weaknes ses of Japanese corporate governance and the me rits of
various solutions. Meanwhile, institutional pressures also promote rigidities that
impede change or shape it in particular ways. It is thus important to examine
potential pressures path dependence, including how pressures for change are
constrained by power and politics.
8 This section draws upon material in Jackson and Miyajima (2007).
9 M&A Consulting Inc (MAC) was founded by Yoshiaki Murakami (an ex-MITI oYcial) with
Wnancial backing of Softbank and made unsuccessful bids for Shoei Corporation in 2000 and Seibu
Railway Co Ltd in 2005, as well as submitting a widely publicized shareholder proposal at Tokyo Style.
Murakami was indicted for insider trading in June 2006. AUS private equity Wrm (Steel Partners Japan
Strategic Fund) made two failed bids for Sotoh and Yushiro in 2003. The targets of MAC and Steel
Partners have been cash-rich and pay low dividends, have low degrees of bank dependence and high
foreign ownership, but haven’t performed systemically worse than listed companies as a whole
(Maezawa 2005; Xu 2006).
Change of Corporate Governance in Japan 15
Institutional theory stresses that corporate governance systems may exhibit
path dependence due to lock-in through sunk costs (North 1990), the presence of
private beneWts accruing to particular groups (Bebchuk and Roe 1999), and
powerful actors which may eVectively block or shape change (Crouch 2005).
Also, adopting a new practice may be eVective or viable only in combination
with other organizational practices and supported by a broader institutional
framework outside the individual Wrm (Aoki 1994: 34). The diVusion or borrow-
ing new corporate governance institutions may face serious barriers and isolated
or incremental eVorts to change past strategies may be ineVective within some
coordinated eVort to change.10 However, complementarities also suggest dynamic
potential for change, since initial changes in one direction may gain momentum
through positive feedback with institutions in other domains (Milgrom et al.
1991).
Given such institutional rigidities, corporate governance reform in Japan has

been carried out in an incremental fashion. A long series of amendments
were made to the Commercial Code and other related laws throughout the
1990s (see Table 1.3). Various associations such as the Japan Corporate Directors
Association, the Japan Corporate Governance Forum (JCGF), the Shareholders
Ombudsman, or most recently the Pension Funds Association strongly advocated
greater attention to shareholders and board reforms, such as outside directors.
While these groups are eVective in highlighting issues and galvanizing public
opinion, but their political inXuence over the government ministries and political
parties that shape policy is limited compared to major industry associations, such
as Nippon Keidanren. Meanwhile, the major industry association (Keidanren),
the em ployers’ association (Nikkeiren), and the Japan Association of Corporate
Executives (Keizai Doyukai) largely opposed reforms that would represent major
inroads against managerial autonomy (Keizai Doyukai 1996; Keizai Doyukai
1998; Nikkeiren 1998).11 For example, Keidanren remained opposed to introdu-
cing mandatory independent outside directors. Given their opposition, actual
corporate governance reforms have focused largely on improving the inde-
pendence of statutory auditors or giving Wrms the option to voluntarily adopt
a new ‘‘company with committees’’ system modeled on US boards. Business
associations have favored reforms that would facilitate corporate restructuring
and give management greater Xexibility in the use of corporate equity. Meanwhile,
despite much talk about shareholder value, the basic notion of stakeholder-
oriented corporate governance seems largely intact.
How substantial is the cumulative impact of these changes? In the next
section, we review the main Wndings from the empirical chapters of this book
in order to address the degree and direction of change in Japanese corporate
governance.
10 Complementarity may imply non-concavity whereby no change in one dimension, no matter
how large, can improve performance (Roberts 2004). Nor will simultaneous but small changes in
multiple dimensions improve performance. We are indebted to Hideshi Itoh suggesting these points.
11 Nikkeiren and Keidanren subsequently merged to form Nippon Keidanren.

16 Gregory Jackson and Hideaki Miyajima